Insurance stocks often look like lousy investments in a slow economy. Demand for policies can shrink as unemployment rises, and rivals undercut each other on price to snag whatever market share still remains. But you want to own these stocks when the economy is still weak, as most investors fail to appreciate the robust upside to come once unemployment drops and competitors call a pricing truce.

Employers Holdings, Inc. (NYSE: EIG), which provides workmen’s compensation insurance, looks like a classic early-cycle insurance play. The stock is so unloved that it trades at just 70% of book value, and sports a single-digit earnings multiple on trailing earnings, even though those earnings are at abnormally low levels. As earnings rebound, and the stock’s price-to-earnings (P/E) ratio expands, savvy investors may be looking at a massive move up in its stock price.

Employers Holdings pulled off a well-received IPO, at $525 million and $172 million, respectively. Although the economy had not yet cooled yet, the insurance pricing trends turned negative in 2007, dragging results lower in 2007, 2008 and again in 2009. (Sales actually grew in 2009, though only due to an acquisition completed earlier in the year).

Net income, though, could not escape gravity’s pull in 2009, and came in at just $83 million, less than half of the income generated in 2006. Here’s the thing, though: Profits have been trending down, but they are still quite robust. And that has enabled management to keep doling out value to shareholders.

#-ad_banner-#For starters, the company pays out a modest $0.24 annual dividend, which translates to a yield of about 1.8%. More important, Employers Holdings continues to buy back large blocks of stock. The share count shrank from more than 50 million in late 2007 to a recent 44 million. And thanks to the current buyback, the share count could fall below 40 million by sometime in 2011. The rising levels of cash have strengthened the balance sheet, which when coupled with that shrinking share count, is leading to an impressive spike in book value. In the most recent year, book value per share rose +19%, to $20.67 from $17.43. At the time of its IPO, shares traded above $20 and book value stood at around $14 per share. Now, those numbers are reversed.

For shares to gain traction — and move back up to book value and beyond — the company will need to reverse the recent sales trends. If history is any guide, that should transpire in a two-step fashion. First, a reduction in the unemployment rate should boost demand for worker’s compensation policies. A year or two later, insurance carriers should have ample room to start raising prices again, which have been shrinking in recent years. Both of those factors should help boost per share profits back to around $1.40 in 2011, and perhaps above $2.00 in 2012. Notably, per-share profits exceeded $2.00 in 2007 and 2008, and soared above $3.00 back in 2006, the last time the cycle was truly favorable. And that was with a notably higher share count, so per share profits could set new peaks in the next cycle

Right now, investors will need to find solace in the steadily rising book value, the rapidly shrinking share count, and an unemployment rate that works its way slowly lower. As the cycle turns, the reward should come from heady capital gains.